As we head into the end of 2025’s first quarter, there are two companies in Royce Small-Cap Total Return Fund that we think are worth highlighting as both are entering pivotal times in their respective executions on strategy and objectives: MSC Industrial Direct (NYSE: MSM) and The Hackett Group (Nasdaq: HCKT).

MSC Industrial Direct is an industrial distributor that has developed a specialty around metalworking tools and is therefore exposed to heavy manufacturing. After having gone through an extended period of declining margins that began in 2015 as pricing transparency from e-commerce ate into profits from its quick turn business, the company announced its “Mission Critical” strategic initiative in 2020 that was focused on both customer-facing and back-office areas. The initiative leaned into the company’s value-add services, manufacturing expertise, offerings that could penetrate deeper into its customer’s operations, and significant cost reduction plans. These efforts helped to stabilize the margin declines, established its market position more firmly around high touch business, and allowed MSC to recently introduce a second round of strategic initiatives that we think position the company for success over the next few years.

MSC Industrial Direct (NYSE: MSM)
2/29/24-2/28/25

Past performance is no guarantee of future results.

We think MSC has made strong leadership changes by bringing in the necessary talent to drive a profitable evolution, first by hiring CFO Kristen Actis-Grande in 2020, who we think was instrumental in driving the success of Mission Critical. Then, late in 2022, the company hired COO Martina McIsaac, who has been building operational excellence to prepare MSC for its next round of initiatives. McIsaac is now spearheading efforts to drive increased growth, including improving the company's digital offerings for a better customer experience, improving pricing tools for better win rates and profitability, redesigning sales coverage for better customer reach, and optimizing supply chain and inventory management for enhanced customer service and profitability. We think this new strategic effort led by McIsaac will usher in a genuinely pivotal shift for the company, both for its underlying financial performance and for its perception among investors.

One critical consequence of these changes has been to reinvigorate growth, specifically with MSC’s core customer base, which is mostly comprised of small and medium size businesses. While the company has also seen success with national accounts, we suspect that the objectives laid out above will help MSC to continue reconnecting with those core customers, driving improved outcomes to their experience. This is also important from both a topline growth and a margin perspective as this cohort is considerably more profitable to serve.

In addition to being excited about the potential of these new strategic initiatives, we think the company is well positioned to benefit from a potential rebound in short-cycle industrial activity in the U.S. For example, the ISM Manufacturing PMI recently moved into expansion territory for the first time since early 2022, which should correlate positively with industrial activity. We are beginning to see other green shoots in similar macro data. Furthermore, we think that MSC can benefit from the trend of reshoring manufacturing, as the company possesses critical expertise in manufacturing. We think that this technical expertise can make MSC a critical partner for their clients, which is one reason that we like to hold value-add distributor business models in the Fund.

The Hackett Group is an IT services company that provides a broad range of offerings, from research advisory to implementation services. A long-time holding based on our view that the company has been able to monetize its unique data set that is based on years of experience doing benchmarking and performance studies for the Global 2000, in addition to Hackett’s strong consulting services. The pivotal moment for Hackett in our view is the advent of Generative Artificial Intelligence, or Gen AI.

The Hackett Group (Nasdaq: HCKT)
2/29/24-2/28/25

Past performance is no guarantee of future results.

In fact, we have been impressed by how quickly the company has shifted its strategic focus from a strong investment cycle in its advisory and intellectual property businesses to being laser focused on implementing a strategy to best harness its market position for the tidal change in the tech landscape that is being driven by Gen AI. Of course, nearly every enterprise in the world is now focusing to some degree on Gen AI, as many see it as an advancement that may ultimately prove as monumental as the Internet, mobile computers, and cloud technology. Yet few people are clear-eyed about how exactly to harness its power. We think Hackett is uniquely positioned to be an important service provider in this technological shift.

The company has built their AI XPLR tool with speed and very little capital. AI XPLR is a Gen AI assessment platform that helps clients pinpoint opportunities to operationalize AI in ways that are specific to their needs and operations. Although still in the early stages, this tool has already generated a lot of inbound client interest. To round out this offering, Hackett acquired LeewayHertz in late 2024, bringing strong AI talent and a platform extension for XPLR called ZBrain. While XPLR helps clients to generate proof-of-concept ideas for AI use cases, ZBrain helps them move those ideas into production and to scale the operations. We think this combination puts Hackett in an enviable position as the Gen AI hype cycle shifts from building out large language models, which we’ve been seeing since late 2022, to now being put into real enterprise use cases.

We also see strong confirmation of the large market opportunity in front of HCKT given that the company has had ample success drawing top talent away from much larger firms to fill out their leadership ranks. When experts in a given field see the opportunity that we are seeing and are willing to walk away from roles at larger firms, that adds an element of extra validation to our conviction.

We see at least two ways that Gen AI can drive strong fundamental growth for Hackett. The company has always had what we think is a highly effective business model where new revenue would flow from their research offerings downstream into advisory and implementation, thereby limiting the need for outbound sales and marketing expense. We expect that the Gen AI offering will accelerate the benefits of this model, dramatically increasing the top of funnel activity and inbound client interest. In other words, we think that the Gen AI offering will not only foster a strong revenue stream on its own but will also help to boost growth for the remainder of Hackett’s business.

In addition, Hackett has created an intriguing joint venture model that will house the AI XPLR and ZBrain offerings. This venture was set up as part of the LeewayHertz acquisition and is led by that company’s founder. We find this setup particularly interesting as it has the potential to highlight the value of their software offering through the joint venture, while also being structured in such a way that as to keep the entire unique dataset completely under the company’s asset base and control.

We think The Hackett Group is a great example of a holding where the potential exists for a radical shift in investor perceptions as the company emerges from a strategic pivot riding a wave of strengthening fundamentals.

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